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Red Herrings Can Be Interesting

It strikes me that there is often an inverse relationship between the heights of an essayist’s rhetorical flourishes and the depth of the scientific evidence they marshal to support it. I give Mark Thoma high marks for raising the rhetorical stakes in this debate to the point where those who remain more skeptical of the evidence for substantial increases in income inequality since 1989 are relegated to the status of contrarian ideologues unwilling to sign onto Mr. Gore’s “Inconvenient Truth.” But isn’t this a bit much, even for a true believer?

Rather than raise the rhetorical level it might have been more interesting for Thoma to acknowledge the new evidence I provided in Figure 6. It demonstrates how changes in top coding and censoring both in the public use and in the internal Current Population Survey (CPS) data significantly inflate inequality trends, especially in the 1990s. That is, they are much higher relative to trends based on that same data which has been consistently top coded; in each year, each income source is top coded at the same point in its distribution.

This standard practice in the labor earnings and income inequality literature shows that, at least as far as the CPS data are concerned, there has been little increase in income inequality in the bottom 99 percent of the income distribution since 1989 as measured by standard Gini coefficients. And much of that increase is likely due to changes in US Census data collection processes that show up in the 1993 internal CPS data and in the 1996 public use CPS data.

But the news is even better: unlike the business cycle of the 1980s, where a small but significant share of the income distribution got worse (see Figure 2) over the 1990s business cycle (1989-2000), the entire distribution moved to the right. A person at every point in the distribution in 2000 was better off in real terms than his counterpart at that point in the distribution in 1989.

That is something that did not happen in Germany or Japan, two countries with much bigger and more progressive income tax systems and a willingness to interfere with markets to reduce income inequality greater than that in the United States. Despite their progressive efforts, income inequality increased more in both these countries over their 1990s business cycles than in the United States. This fact should at least give Thoma, and others who are so ready to make things better though redistributive policy, reason to pause and to consider whether their proposed changes would really do more good than harm.

As for Reynolds and Burtless, I continue to suspect that there is fundamentally little difference between my findings and their findings with respect to the bottom 99 percent of the income distribution. And I continue to suspect that our differences with respect to the way inequality within that population changed over the last 25 years is less than our conversation to date would suggest. But it will require a painstaking comparison of footnotes to be sure. But that should not be surprising: this kind of detailed work is what careful research done on imperfect data sets requires.

Burtless puts great emphasis on a break point between 1979-1994 (the start of the strong economic expansion) and 1994-2004 in his discussion. But my reading of Figure 6 (see especially the consistently top coded internal Gini values which I believe are the most appropriate to consider) suggests that inequality rose dramatically from 1979-1983 and much less thereafter. This is not a trivial observation. 1979-1983 was a difficult time in the United States. It began with a couple of years of double-digit inflation and ended with the most serious recession since the Great Depression.

In my view this was the price our economy paid for a decade of failed Keynesian policies and stagflation. However, this dark period of macroeconomic outcomes also marked the end of federal government macro policies based on Keynes’s economic principles. The Reagan Administration put into place a series of macroeconomic policies practiced by all subsequent presidents, both Republican and Democrat: the Federal Reserve Board Chairmen they have appointed have focused primarily on an inflation target, and the federal government has increasingly allowed free markets to work their magic.

What has happened to income inequality since then? My reading of Figure 6 is that there was little change in income inequality from 1983 to 1992. There is then a major spike in the data in 1992-1993, which to some degree is caused by changes in US Census data collection procedures. From 1993 to 2004 there is no change in consistently top coded internal CPS data. Hence for the bottom 99 percent of the income distribution — except for the largely unexplained spike in 1992-1993 — there has been remarkably little increase in income inequality.

One can certainly argue that there has been no decreases in income inequality either. Hence, since 1983 the United States has had a substantially higher, but relatively constant, level of inequality than we experienced in previous decades. But during the past 20 years (at least for the bottom 99 percent of us) people at all points on the income distribution have experienced increases in economic well-being with little additional increase in income inequality.

So what’s all the shouting about? In my view it is about what the CPS and especially consistently top-coded CPS data can not directly tell us. What about that other 1 percent? Here Reynolds and Burtless strongly disagree. Reynolds argues that even including that 1 percent in the mix there has been no great increase in income inequality since 1988 and Burtless offers counter proof based on other data sets. I am not yet sure who is right between them, but I am very sure that Thoma is wrong. It is still reasonable to be skeptical of both arguments.

Also from this issue

Lead Essay

A headline in today’s Wall Street Journal reads “Fed Chief Warns of Widening Inequality.” Bernanke worries that inequality erodes tolerance of the “dynamism” that lays the golden eggs of “economic progress.” But is inequality widening at all? Cato Institute senior fellow Alan Reynolds has his doubts. Following up his own controversial Wall Street Journal op-ed, a Cato Institute policy forum, and a new Cato policy paper, Reynolds in this month’s lead essay digs yet deeper into the mysteries of the official numbers and comes up with … not much: “If there were any [good] data showing a significant and sustained increase in the inequality of disposable income, consumption, wages, or wealth since 1988,” Reynolds concludes, “I suspect someone would have shared it with us by now.”

Response Essays

Gary Burtless agrees that analysts of the American income distribution should “take seriously some of Reynolds’s criticisms of the data on income disparities.” “Reynolds points to some serious problems,” Burtless concedes, “and in many cases fair-minded experts will agree with him.” Nevertheless, Burtless dissents sharply from Reynolds’s larger claim that inequality apparently stopped increasing in the late 1980s. “Income inequality was higher at the end of the 1980s than it was in the beginning of that decade,” he states, “and it was higher in 2005 than it was in 1989.” According to Burtless, Reynolds can reach his unorthodox conclusion only by manipulating the evidence. “The problem is,” Burtless charges, “he is harshly critical of data series that do not support his views, while he is usually silent about equal or more serious problems with data sets that show little change in inequality.”

In his response to Alan Reynolds, Mark Thoma invites us to “step back” and survey the wider picture of data and expert opinion on income inequality. The verdict? Fed Chairman Ben Bernanke, and the consensus generally, has got this one right. “The preponderance of evidence and of professional opinion,” writes Thoma, “clearly indicates that inequality has been rising since [at least] 1988.” Like Burtless, Thoma finds little in Reynolds’ analysis to agree with, describing his main points as “either too inconsequential to change the inequality picture,” suffering from “an incomplete presentation of the evidence, or rebutted by other work.” Thoma then goes a step further, pointing to new evidence suggesting that income inequality might be even greater than currently estimated.

Invoking Kurosawa and Derrida, Richard Burkhauser dives into the contested complexities of the Current Population Survey data on household income. His conclusion: “Over the 1990s business cycle the entire distribution moved to the right with little or no change in income inequality. Since 1989 household income inequality has risen very little and much less than in the previous decade. This is very good news that matters.” Burkhauser admits that the CPS data are not well suited to tracking trends for the top 1 percent of earners. “But does this really matter?” he asks. “Our economy is not a zero sum game. My gain does not mean your loss or vice-versa. I know of no evidence that increases in the incomes of the top 1 percent of our population are the root cause of the challenges faced by those at the other end of the distribution.”

Dirk Krueger and Fabrizio Perri suggest that we shift our attention away from inequality in current incomes. “[I]f one is ultimately interested in the distribution of well-being across U.S. households,” they write, “the object of study ought to be the joint distribution of lifetime consumption and leisure across them.” Unfortunately, good data on lifetime consumption are not available. However, citing Milton Friedman and Franco Modigliani, Krueger and Perri contend that “if households can borrow and lend on financial markets, then there is a strong link between the lifetime resources of a household (sometimes also called its permanent income) and its current consumption.” And the trends in current consumption data show that “the increase in income inequality in the U.S. has been much more pronounced than the corresponding increase in consumption inequality.”

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